The Bull Bear Trader discusses market events and news with an interest in understanding risk and return in both bull and bear markets. Discussion topics include trading and hedging strategies, derivatives, risk management, hedge funds, quantitative finance, the energy and commodity markets, and private equity, as well as an occasional investment opinion.

The option strategy of buying stock and then writing call options against it - known as buy-write - is still generating some of its highest premiums in over 20 years (see WSJ article). By using a hypothetical version of the strategy using the BMX index as a comparison, the CBOE found that a buy-write strategy would have produced an 8.1 percent gross monthly premium in November, topping the second highest recent premium of 7.1 percent generated in October just a month earlier. Since June 30, 1986 until the end of October, 2008, the strategy has generated an average annualized return of 9.2 percent, while the S&P 500 index produced a return of 8.7 percent over the same time period. While volatility will not always be as high as it is now, nor will it always generate healthy option premiums and a nice return over the S&P 500, even an average 0.5 percent extra return over more than 20 years starts to look pretty good - not to mention compounds into some significant cash.

For those a little intimidated by option strategies, keep in mind that with a buy-write strategy your obligation for the written call is covered by owning the stock (a covered call). Therefore, you don't have the same potential "infinite" loss that scares away many investors from writing options. Of course, there are downsides. Besides the fact that your long position could decrease in value, an additional downside is that your long stock position could be called away if the stock produces a significant move - causing you to potentially leave some money on the table. Nonetheless, the strategy forces a sell discipline, which for many is the most difficult part of investing. For instance, if a 3-month call has an exercise price that is 20 precent away from the current price of the long stock position, then the stock could be called away once its price rises more than 20 percent in 3 months. Certainly disappointing when the stock moves much more than 20 percent, but you still lock into 20 percent (plus the premium) in 3 months or less. Not bad in my book. In the mean time, the premium provides additional downside protection, just in case you end up not picking a winner. For those interested, some additional information on buy-write strategies can be found here, here, and here.